Modifications to tax law that are to be pursued as part of President Donald Trump’s overall federal tax reform plan may include changes to how the optional and mandatory flat income tax rates for supplemental wage withholding are determined.
Under current federal law, the optional flat rate for federal income tax withholding on supplemental wages must equal the third-lowest tax rate among those used for progressive income taxation on regular wages and the mandatory flat rate for supplemental withholding must equal the maximum federal income tax rate on regular wages, said Sally Thomson, CPP, director of payroll training at the American Payroll Association.
Trump and congressional Republicans have proposed reducing the number of federal income tax brackets, and hence the number of tax rates applicable for federal income tax withholding on regular wages, to three from seven, Thomson said May 20 at the annual American Payroll Association Congress in Orlando, Fla.
“If President Trump gets his way and there are three tax brackets, it is uncertain what would happen,” as the third-lowest rate would be the same as the maximum rate because there would be only three rates for federal income tax withholding on regular wages, Thomson said.
If Trump and congressional Republicans determine that, as part of their overall federal income tax reform plan, it still would be desirable for optional and mandatory flat-rate withholding on supplemental wages to be permissible, “the rules for determining the optional and mandatory flat withholding rates might be adjusted if we get down to three brackets.”
The seven current tax brackets under federal law, which have applicable tax rates that have been in effect since 2013, include rates of 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent. The optional federal flat rate for supplemental wage withholding consequentially is 25 percent and the mandatory federal flat rate for supplemental withholding is 39.6 percent.
Trump proposed in an income tax plan released April 26 to eliminate the tax brackets with rates of 15 percent, 28 percent, 33 percent and 39.6 percent and retain only the tax brackets of 10 percent, 25 percent and 35 percent.
Employers may use the optional flat income tax rate for withholding on an employee’s supplemental wages if income tax was withheld from the employee’s regular wages in the current or previous year, if the supplemental wages either are separately stated from regular wages on pay statements or paid separately from regular wages, and if the total amount of supplemental wages paid to the employee so far during the current year does not exceed $1 million. Thomson said.
Supplemental wages that would be eligible for tax treatment using optional flat-rate withholding alternatively may be taxed using the aggregate withholding method, in which regular wages and supplemental wages are combined into a total amount upon which withholding is calculated using the federal income tax withholding tables, with the percentage-method tables generally used instead of the wage-bracket tables, Thomson said. The aggregate withholding method must be used for supplemental wages when they are not reported separately from regular wages, she said.
The mandatory flat rate of federal income tax withholding must be used on supplemental wages paid to an employee during a year if the total amount of supplemental wages already paid to the employee that year was at least $1 million, Thomson said.
If an employee during a year did not have total supplemental wages of at least $1 million but receives a payment that causes the total supplemental wages paid to the employee that year to pass the threshold of $1 million, the mandatory flat rate must apply to the part of the updated total amount of supplemental wages that exceeds $1 million, Thomson said. However, when a supplemental wage payment causes the $1 million threshold to be passed, the part of the payment that when added to the previous total of supplemental wages would be $1 million may be taxed at the optional flat rate, she said.
Instead of using the optional flat rate and mandatory flat rate on separate parts of a supplemental wage payment that causes an employee’s total supplemental wages for a year to pass the threshold of $1 million, the Internal Revenue Service allows employers to apply the maximum federal income tax rate, which is equivalent to the mandatory federal flat rate for supplemental wages, to the entirety of that supplemental wage payment, Thomson said.
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